Why Asia isn't buying the Senate bailout

Investors didn’t find much to cheer in Wednesday’s Senate approval of the revised bailout plan, reasoning that the House vote later in the week is the bigger hurdle to climb. An index of Asian equity markets hit a three-year low and is so far down around 32 percent this year. Stocks initially rose Thursday on talk of the US bailout package, but the euphoria soon died.

Japan set the bearish mood, as manufacturers like Toyota turned pessimistic over their earnings at home and abroad. Many consumers are also more hesitant to spend, stoking fears of lower growth, according to a Japanese government survey.

The doom and gloom might seem overdone, as Asia isn’t holding much of the toxic securities that have felled once mighty US and European financial houses. Sure, there was panic in Hong Kong last week over one bank seen as unstable. But that run was quickly averted when a local billionaire bought into the bank.

Credit markets in Asia have seized up, prompting central banks in Japan, China, Australia, and elsewhere to pump in money to keep them going. But there isn’t yet the same panic that has afflicted the US and Europe.

What does worry investors is that spendthrift Americans are about to become more frugal, by necessity rather than choice. That’s bad news for producers in Asia who rely on external demand.

A decade ago, it was East Asia that suffered a financial meltdown.

Linda Lim, a Singaporean who is a professor of strategy at the University of Michigan’s Ross School of Business, recalls that Asian governments were scolded then for their lax regulations of financial markets. In the aftermath of the 1997 crisis, Western investors snapped up assets at fire-sale prices.

Now the shoe is on the other foot. Will Asians return the favor by plowing their surplus capital into US assets, thus keeping Wall Street – and by extension Main Street – afloat? A Japanese bank has already bought a chunk of Morgan Stanley.

Don’t bet on it, write Ms. Lim. Sovereign wealth funds are worried that US politicians may block takeovers. Lehman went bankrupt last month after trying and failing to sell a stake to a state-owned South Korean bank. China is still wondering if it got burned by buying a piece of Blackstone.

Nor will Asian consumers pick up the global slack if Americans start spending less. Yes, US exports have risen on the back of a weak dollar, but Asia isn’t about to go on a made-in-America buying spree. Consumers and governments prefer to save for a rainy day, it seems.

This isn’t to say that Asia doesn’t have a major stake in how Washington handles the credit crunch. It does, and policymakers are watching closely to see what happens to the financial sector and, crucially, to the dollar.

That’s because Asia has stashed its savings in US government debt, helping America to keep interest rates low and spend more freely. It was a back-scratching formula that allowed countries like China to keep their currency cheap and keep exporting to indebted Americans.

Former Treasury Secretary Larry Summers called this arrangement a “balance of financial terror,” as it locks in creditors like China and Japan into the dollar, the world’s reserve currency. Plenty of other economists took note of the imbalance, too, and its political implications.

Writing earlier this year in The Atlantic, James Fallows calls it the $1.4 trillion question. What happens if China wants its foreign reserves back? Or will it keep indefinitely propping up American consumption as long as it sustains China’s own export-led growth?

That question seems ever more pertinent as economists fret over the risk of a prolonged US downturn, one that would be felt acutely in Asia.